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Running head: HALLSTEAD JEWELERS

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Hallstead Jewelers Group One Members Florida Institute of Technology Managerial Accounting BUS5431 Term Fall 1 2016 Professor Art Gilbert 9 October 2016

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Hallstead Jewelers Hallstead Jewelers is faced with several factors that has affected the company’s profits. Change can impact the financial stability of a company as well can impact the culture of a well-established organization. Homestead Jewelers was located at Lake Avenue in a popular location in one of the largest cities in the Tri-State area. After 85 years in one location Hallstead Jewelers had an outstanding reputation for fine quality products. The company maintained the same routine and tradition that had not change since its beginning. It was not until the unfortunate deaths of the company founder (Grandfather), and a few years later their Father, did things start going wrong for Hallstead Jewelers. The business was inherited by daughters Gretchen and Michaela who are now tasked with the decision making and problem solving for the company. Due to a combination of issues including declining sales since 1999; the signing of a 5-year lease; a move to a new, larger location; costs associated with the renovations of new retail store; and loss of return customers, the business has shown negative financial figures. An analysis of the company’s financial documents has determined that many of the issues stem from the move to the new location, the associated costs and an a disproportionate increase in sales volume. Hallstead Jewelers reflects a break-even point that equals the fixed cost divided by the company’s contribution margin per unit. 2003 Gross Margin Total expenses Net income

2004 $4,257 3,679 578

Hallstead Jewelers

2005 $3,970 3,758 212

$5,141 5,547 (406)

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Break – Even Point in Number of Sales Tickets 2003 2004 2005 Break-even in units (fixed costs / CM per unit) 4,535 5,000 7,505 Break-even sales (fixed costs / CM ratio) $7,287.03 $7,620.20 $11,655.34 Margin of safety (expected sales less break-even $1,295.97 $481.80 ($944.34) sales)

Break-even point in number of sales tickets calculations are as follows: The break even in units Break-even in units (fixed costs / CM per unit) 2003: (3,250 / 797.04) = 4,078 2004: (3,353 / 746.80) = 4,490 2006: (5,011 / 745.40) = 6,723

Break-even sales Break-even sales (fixed costs / CM ratio) 2003: (3,250 / 0.4959) = $6,552.68 2004: (3,353 / 0.4900) = $6,842.82 2006: (5,011 / 0.4799) =$10,440.15

Margin of Safety Margin of safety (expected sales less break-even sales) 2003: ($8,583 - 6,552.68) = 2,030.32 2004: ($8,102 - 6,842.82) = 1,259.18 2006: ($10,711- 10,440.18) = 270.82

Hallstead Jewelers Category Costs Salaries Commission Advertising Administrative expenses Rent Depreciation Miscellaneous expenses

Sales Cost of goods sold

Type Fixed Variable Fixed Fixed Fixed Fixed Fixed

Hallstead Jewelers Income Statements Year Ending in, January 31, 2006 2003 2004 $8,583 $8,102 4,326 4,132

2006 $10,711 5,570

HALLSTEAD JEWELERS Gross margin Expenses Selling expense Salaries Commission Advertising Administrative expense Rent Depreciation Miscellaneous expense Total expense Net income

Sales space (square feet) Sales per square foot Sales ticket Average sales ticket

4 $4,257

$3,970

$5,141

2,021 429 254 418 420 84 53 $3,679 $ 578

2,081 405 250 425 420 84 93 $3,758 $ 212

3,215 536 257 435 840 142 122 $5,547 $ (406)

Hallstead Jewelers Operating Statistics 2003 2004 10,230 10,230 $ 839 5,341 $1,607

$ 792 5,316 $1,524

2006 15,280 $ 701 6,897 $1,553

Based on the analysis, we see that the sales figures required for Hallstead to break even dramatically increased from 2004 to 2006, primarily due to the substantial increase in salaries and rent. In 2004, the projected required break-even revenue, based on a total sales ticket volume of 5,316 tickets, would be $6,842,820. In 2006, the total sales ticket volume increased to 6,897 total tickets, but due to the increase in total fixed costs, the required amount of revenue to break even rose to $10,440,150, a net change of $3,887,470. With the dramatic shift in required break-even revenue required between 2004 and 2006, the Hallstead team so an equally dramatic shift in the overall margin of safety. In 2004, the margin of safety was 1,259,180 as compared to $270,820 in 2006. As previously stated this decrease can be directly related to the increase in salaries required to manage the new store and

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the overall increase in rent and associated fixed administrative fees associated with the new facilities. Potential Solutions As part of the consulting project sponsored by Gretchen Reeves and Michaela Hurd, the consultant was tasked with coming up with potential solutions that could help stem the losses that the Hallstead sisters were seeing in the new store location. One of the potential solutions was to decrease average ticket sales by 10% with the expectation that the total ticket volume would increase from the 6,897 tickets seen in 2006 to a new total of 7,500 cumulative sales tickets. Using increment cost analysis we see the following impacts of the proposed solution:

Sales Cost of goods sold Gross Margin COGS per unit Expenses Selling expenses Salaries Commissions Advertising Administrative expenses Rent Depreciation Miscellaneous expenses Net income

Total fixed costs

Sales Space Sales per square foot Sales tickets Average sales ticket

2006 (7500/10%) $10,483 6,057 $4,426 807.60

3,215 525 257 435 840 142 122 $

5,536 (1,110)

5,011 2006 (7500/10%) 15,280 $701 7500 $1,398

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CM per unit CM ratio

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$590.10 0.422193176

Hallstead Jewelers Break – Even Point in Number of Sales Tickets Break-even in units (fixed costs / CM per unit) Break-even sales (fixed costs / CM ratio) Margin of safety (expected sales less break-even sales)

2006 (7500/10%) 8,492 $11,868.97 ($1,386.26)

As illustrated in the calculations, the projected gross sales receipts would actually decrease from the 2006 high of $10,711,000 to $10,483,000 even with an in increase in sales tickets of 603 tickets. In addition to the decrease in overall revenue, the overall variable costs would increase from $6,106,000 to $6,582,000 or a net increase of $476,000. The combination of an overall decrease in net sales and a net increase in variable costs, makes the proposal of a 10% decrease in average selling price for an increase in overall ticket volume a losing proposition for Hallstead. Eliminate Sales Commission Hallstead’s had a company history of paying commissions to its employees. And while this may have helped get the business started and contributed to their success, Gretchen knew that something needed to change to make Hallstead’s profitable again. Based on the figures below, she knew that the sales commissions needed to be eliminated to help keep her breakeven volume at a level that would lead to more profits for the store. If Gretchen had eliminated the sales commissions in 2006, the breakeven volume would have decreased by 782 sales tickets which would have decreased the breakeven price of sales by $1,214,446. By eliminating the sales commissions in 2006, Gretchen would have seen a profit instead of a loss.

HALLSTEAD JEWELERS

Sales Cost of goods sold Contribution margin Expenses Selling expense Salaries Commissions Advertising Administrative expense Rent Depreciation Miscellaneous expenses Total expenses Net income

Sales Tickets Average sales tickets Variable cost per ticket

CM per unit CM ratio

Sales tickets Sales dollars

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Hallstead Jewelers Incremental Analysis 2006 2006 Income Statement No Commission $10,711,000 $10,711,000 5,570,000 5,570,000 $5,141,000 $5,141,000

$3,215,000 536,000 257,000 435,000 840,000 142,000 122,000 $5,547,000 -$406,000

$3,215,000 0 257,000 435,000 840,000 142,000 122,000 $5,011,000 $130,000

Breakeven Point (customer orders written) 2006 2006 No Commission 6,897 6,723 $1,553 $1,553 $808 $808

$745.40 0.47997424

Breakeven Point (sales dollars) 2006 Original No Commission 6,897 6,723 $10,711,041 $10,440,144

Incremental Revenue and Costs $0 0 $0

$0 -536,000 0 0 0 0 0 -$536,000 $536,000

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Breakeven volume would go down by 782 sales tickets and sales to breakeven would decrease by $1,214,446 (7,505 – 6723 tickets x $1,553). Advertising Increase Michaela Hurd and Gretchen Reeves are experiencing a decline in sales. Michaela feels that a bigger store could benefit from greater advertising. She suggested to her sister Gretchen that they should increase advertising by $200,000. Currently, their business requires $11,653,488 dollars in sales to break even. If the advertisement cost is increased to Michaela’s recommended amount the business would require $12,118,604 dollars in sales to break even. That is a difference of $465,116 dollars in sales required to cover the additional costs. If Michaela can guarantee an approximate increase in sales of four percent, then it would be advisable that the sisters increase their advertisement. Average Break-even Ticket Price Increase The last possible approach that the sisters can take is to potentially increase the overall average ticket price in order to bring the new, larger location to a break-even posture. Based on the current cost profiles, the Michaela and Gretchen know that they can keep their overall fixed costs the same in 2007 as they did in 2006. They also project that they can sell the same number of tickets in 2007. With these assumptions in hand, the sister team projects the following for potential break-even ticket increases:

Contribution Margin Ratio =

SP - VC SP

HALLSTEAD JEWELERS

$10,711,000

9 Varible cost (COGS + Commission)

$6,106,000

Selling Price

$10,711,000

Contribution Margin Ratio =

Dollars needed to break even =

TFC -

0.43

Profit

Contribution Margin Ratio

Dollars needed to break even = Dollars in sales needed to break even =

$5,011,000 0.43

TFC (Fixed Selling Expenses) CM

$11,653,488.37

Based on this projected dollar figure, we know that Hallstead needs approximately $1,170,778 in additional revenue to break even in 2007 based on steady fixed costs. With the assumption of 6,897 tickets staying steady in 2007, the average ticket price would need to increase by approximately $170 per ticket in order to make the store break even ($1,172,469/6,897 = $169.75). Breakeven point if advertisement cost is increased by $200,000 Taking the analysis one step further, the team analyzed what the required ticket sales would need to be with the addition of $200,000 of additional advertising added into the total fixed costs. Based on the calculations below, the overall breakeven sales figure would adjust up to $12,118,604.65. Assuming all the costs remain the same and the total ticket count

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remains at 6,897, the overall sales delta would come to $1,635,894.78 which would result in a total sales ticket increase of approximately $237 per ticket ($1,635,894.78 / 6,897 = $237.19).

Dollars needed to break even =

Dollars in sales needed to break even =

$5,211,000 0.43

TFC (Fixed Selling Expenses) CM

$12,118,604.65

Difference in breakeven point

$465,116.28 Conclusion

Recognizing that the jewelry business was changing and in an effort to save the family business, Gretchen and Michaela hired a consultant to assess the current state of the business and make recommendations to improve company profits. One such recommendation was to move to a larger store, which Hallstead Jewelers did in 2006. It was not long before the financial statement showed that the move to a larger location was not enough and that something else had to be done. The second recommendation from the consultant was to increase sales by reducing prices. This idea is not supported by group one as it would reduce overall revenue and increase variable cost in excess of $476,000. The two ideas that the consultants recommended showed a negative impact on Hallstead Jewelers profits. The idea that Michaela had to increase sales by increasing the advertising

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budget by $200,000 was also an idea that would not fare well for the jewelers. In this case the company would have to increase its sales by $465,116 dollars to support this endeavor. The idea that group one supports and recommends is for Hallstead Jewelers to follow a similar business model as its competitors in the city. This model calls for the elimination of sales commissions. Our analysis shows that when applied to year 2006 financial data, Hallstead Jewelers would have had a positive net income of $130,000, versus a loss of $406,000. The overall incremental net income or profit for the elimination of sales commissions is $536,000 and is the correct decision for Hallstead Jewelers to implement.

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Bruns, W. J. (2007, March 8). Hallstead Jewelers. Harvard Business School, 1-4.